Korea000619
Structural Reform in Korea: its Process and Consequences
by
Jong Won Lee, Hyun-Hoon Lee and Doo Yong Yang
Table of Contents
1. Introduction
2.
3.
4.
5.
Structural Reform
Economic Performance
Challenges Ahead
Concluding Remarks
Jong Won Lee: Department of Economics, Sungkyunkwan University, Seoul, 110-745,
Korea. (jwlee@yurim.skku.ac.kr)
Hyun-Hoon Lee: Division of Economics and International Trade, Kangwon National
University, Chunchon, 200-701, Korea. (hhlee@cc.kangwon.ac.kr)
Doo Yong Yang: Korea Institute for International Economic Policy, Seoul, 137-747, P.O.
Box 235, Korea. (yangdy@kiep.go.kr)
1
1. Introduction
On the 21st of November 1997, Korea turned to the International Monetary
Fund (IMF), as the rollover ratio of short-term external borrowings by domestic
financial institutions kept decreasing and the country’s usable foreign exchange reserves
plummeted to US$ 7.3 billion, from US$ 22.3 billion only a month earlier. On the 3rd of
December 1997, Korea and the IMF signed an agreement on a financial aid package
totalling US$ 58.3 billion. The IMF Stand-By Arrangement was subject to a broad range
of conditions, including macroeconomic stabilisation and structural reform.
As emergency measures, the Korean government was required to implement
tight monetary policy, fiscal austerity and the immediate closure of insolvent financial
institutions. In the longer term, the Korean government was required to pursue
economic reform programs in the financial sector, the corporate sector, and the labour
market. Because the Korean crisis had its roots in the weakened fundamentals of the
Korean economy, attempting to stabilise only the financial market without an emphasis
on structural reforms is like treating symptoms without addressing the cause.1 Thus,
since the onset of the financial crisis in 1997, the Korean government has pursued
structural reforms in the areas that the IMF required. In addition, the Korean
government has pursued public sector reform to achieve the efficiency necessary to
keep up with other sectors’ reforms.
This chapter aims to evaluate the post-crisis performance of the Korean
economy with a special emphasis on the Korean government’s structural reform efforts
under the IMF program. Having done this, this chapter identifies potential dangers and
challenges lying ahead, and further discusses the prospects of the Korean economy. The
remainder is as follows. Section 2 presents the structural reform programs of the
financial sector, the corporate sector, the labour market and the public sector. In section
3, economic developments after the crisis are presented. Section 4 discusses the
problems associated with the structural reforms and the challenges that the Korean
economy has to overcome so as to attain full recovery from the crisis and a sustainable
1
Drawing upon the analogy between a financial crisis and a human stroke, Lee (1999) shows how
numerous factors, such as fundamental weaknesses, unfriendly environment, policy mistakes and
exogenous shocks, were systematically intertwined in causing the financial crisis. See also Lee (2000).
2
growth. Section 5 concludes.
2. Structural Reform
2.1. Financial Sector Restructuring
Before the financial crisis, the Korean government was actively involved in the
market. This government-led economic policy was once considered to have led the
nation to its remarkable economic successes in the 1960s-1980s. However, after the
crisis, the IMF, and others, criticised the government-led economic policies as they had
resulted not only in corruption but also moral hazard among enterprises and banks. They
also criticised the Korean government’s imprudent liberalisation of the financial market
during the early 1990s; appropriate supervision and prudential regulation had not
accompanied the rapid liberalisation of the financial market.
Most Korean financial institutions borrowed short-run foreign capital at low
rates, denominated in the US dollar, and made long-term loans at higher rates. These
financial institutions had the belief that the government would not allow them to fail.
This led to a serious mismatch in maturities between borrowing and lending. On the eve
of the financial crisis, short-term loans accounted for 63 per cent of the total foreign
debts of Korea. This fragile debt structure played a crucial role in triggering the
financial crisis. Soon after, the financial crisis exposed the many weaknesses of the
financial sector, such as its unsound lending practices, unhedged foreign borrowing,
weak liquidity positions, and its ineffective supervisory system.
Thus, the financial sector was the area most urgently in need of reform.
Financial sector restructuring was to stabilise the financial system in the short run, and
enhance the soundness and efficiency of financial institutions in the long run. In order to
facilitate the financial sector reform, several financial supervisory authorities were
created or modified in early 1998. The Financial Supervisory Commission (FSC) was
created and the Korea Asset Management Corporation (KAMCO) and the Korea
Deposit Insurance Corporation (KDIC) were modified.
In the wake of the financial crisis, authorities closed or suspended the
operations of a number of non-viable financial institutions. Nine insolvent merchant
3
banks, which had been suspended on the 2nd of December 1997, were required to
submit a rehabilitation plan within 30 days. If their plans did not meet approval then the
institution’s license would be revoked. The remaining merchant banks were each
required to submit a recapitalisation program by the 31st of December 1997. They were
required to at least meet the 4 per cent capital adequacy ratio of the Bank for
International Settlements (BIS) by March 31st, 1998.
Commercial banks were also each required to prepare a plan to meet the BIS 8
per cent minimum requirement. Of the 25 commercial banks, 12 ‘unsound’ banks,
which did not satisfy the BIS ratio requirement of 8 per cent by the end of 1997, were
classified into two categories. Five banks were ‘disapproved’ and seven banks were
‘conditionally approved’. The five ‘disapproved’ non-viable banks were liquidated
through purchases and acquisitions in July 1998. The seven ‘conditionally approved’
banks took corrective actions imposed by the FSC to further improve their soundness.
By the 31st of December 1998, 86 financial institutions (5 commercial banks and 81
non-bank financial institutions) were either closed or had their operations suspended.
The disposal of non-performing loans (NPLs), and recapitalisation, were also
important parts of the financial sector restructuring. By the end of 1998, KAMCO and
the KDIC together financed a total of 40.9 trillion won to settle NPLs and to recapitalise
certain financial institutions. Meanwhile, the number of people employed by the
financial sector had been cut by a third.
Capital market liberalisation and the promotion of FDI were also important
aspects of the restructuring. Various measures were taken by the Korean government to
liberalise the capital market and to promote FDI. The ceiling on foreign investment in
Korean equities was raised from 26 per cent to 55 per cent in December 1997, and was
completely abolished in May 1998. Thus, foreign financial institutions have been
allowed to establish subsidiary banks and security companies, and to set up jointventure banks. Virtually all restrictions on foreign investors’ access to the bond markets
had been lifted by the 1st January 1998.
The restructuring of financial institutions continued through 1999. In 1999, an
additional 23.1 trillion won in public funds were provided for the financial sector
restructuring. Thus, by the end of 1999, a total of 64 trillion won in public funds had
been injected since the outbreak of the financial crisis in 1997. Thanks to the injection
4
of public funds and the massive rights offerings, the BIS ratios of domestic banks
continued to rise. As of the end of 1999, the average BIS ratio of the 17 commercial
banks was 10.8 per cent, which was well above the BIS recommended level of 8 per
cent. At the same time, the total amount of the domestic financial institutions’ NPLs had
rapidly decreased. As of December 1999, they amounted to 51.3 trillion won, which was
only 9 per cent of the total credit in Korea.
Thus far, the restructuring of the financial sector has focused on the clearance
of depressed assets under government supervision. However, the increasing presence of
foreign financial companies in Korea is likely to further drive market-oriented reforms.
With new players in the market, competition among financial companies will become
stiffer. Moreover, as major international banks become larger and more diversified,
strategic alliances and M&As among financial companies in Korea will increase.
Financial holding companies will be established in an effort to nurture larger financial
institutions. Therefore, a universal banking system with financial holding companies
will emerge.
Up to the end of 1999, the financial sector restructuring had primarily focused
on the commercial and merchant banks. However, the restructuring of non-bank
financial institutions has only just started. In fact, many of the investment trust
companies (ITCs), which had expanded their exposure to the corporate sector in 1998
and 1999, are undercapitalisd and hence vulnerable to the corporate sector’s turmoil.
However, the restructuring of ITCs has been postponed several times. The government
had already declared Korea Investment Trust and Daehan Investment Trust to be
insolvent financial institutions, and had agreed to inject 8 trillion won into the two
largest investment-trust firms. Yet, only 3 trillion won in public funds were injected in
early 2000. Confidence in the trust companies has ebbed quickly, their investors
withdrew, and this has put the squeeze on the huge family-controlled conglomerates, or
chaebols, the trust companies biggest borrowers. The Korean government has decided
to provide an additional 4.9 trillion won in public funds to the two troubled investment
trust companies. However, many suspect that the public funds will not cover the total
amount of the two investment companies’ liabilities.
2.2. Corporate Sector Reform
5
The very high leverage of Korean firms played another crucial role in causing
the financial crisis. In particular, the chaebols in Korea tended to borrow excessively
through cross payment guarantees among interlinked subsidiaries.2 By the end of 1997
the top 30 chaebols had debt-equity ratios of 519 per cent, in sharp contrast with 154
per cent in the United States and 193 per cent in Japan. Poor corporate practices and
governance also contributed to the 1997 crisis in the form of inaccurate company
financial information, no credible exit threat, insufficient financial institution
monitoring, and few legal rights and forms of protection for minority shareholders. (Joh,
1999) Hence, the priority in corporate sector reform has been to focus on achieving a
major reduction in corporate indebtedness and bringing corporate practices into line
with international standards.
In January 1998, the then President-elect Kim Dae-jung and the leaders of the
five largest chaebols made an agreement on five principles of corporate sector reform.
The five principles were: (1) heightening of the transparency of corporate management,
(2) prohibition of cross-guarantees between affiliates, (3) improvement of the corporate
financial structure, (4) business concentration on core competence, and (5)
responsibility reinforcement of governing shareholders and management.
Under these five principles, the top five chaebols and their creditors reached an
agreement on debt reduction and other restructuring measures in early 1998, and
verbalised the agenda for chaebol reform as follows:
 Adoption of consolidated financial statements from fiscal year 1999
 Compliance with international standards of accounting
 Strengthening of voting rights of minority shareholders
 Compulsory appointment of at least one outsider director from 1998
 Establishment of an external auditors committee
 Prohibition of cross-subsidiary debt guarantees from April 1998
 Resolution of all existing cross-debt guarantees by March 2000
The Korean government led the way in corporate sector restructuring through
the revision of related legislation and the periodic check of the progress in those agreed
measures. Ten laws related to corporate sector restructuring, such as the Commercial
2
For more discussion of the chaebols, see Yoo (1995), and Lee and Lee (1996).
6
Law and the Securities Exchange Law, were revised in February 1998. Legal
proceedings for corporate rehabilitation and bankruptcy filing were simplified to
facilitate market exit for non-viable firms, and ensure better representation of creditor
banks in the resolution process. At least 50 per cent of the board members should be
outside directors. The rights of minority shareholders were strengthened, by lowering
the minimum shareholding requirements for many shareholder rights. For example, any
shareholder with 0.01 per cent of firm ownership can file a mismanagement derivative
suit.
The top five chaebols were to follow a program of business swaps named the
‘Big Deal.’ The ‘Big Deal’ was pursued to streamline over-investment and enhance
efficiency in such key industries as semiconductors, petrochemicals, aerospace, railway
vehicles, oil refining, power plant facilities, and vessel engines. The plan involved 17
subsidiaries of the five chaebols. In December 1998, the top five chaebols reached
agreement on many of the deals. Tax incentives were provided to those companies. The
agreement involved 19 companies. (There were three non top-five chaebol companies.)
The Big Deal, for the semiconductors, oil refining, aerospace and railway vehicles
industries, was completed. However, the Big Deal for the other industries eventually
failed or has been delayed.
In addition, the top five chaebols were required to reduce their debt-equity ratios
to 200 per cent by the end of 1999 and improve their financial structure by asset sales,
recapitalisation, and foreign capital inducement. Excluding the dismantled Daewoo
Group, the average debt-equity ratio of the top four chaebols fell to below 200 per cent
by the end of 1999, down from 352 per cent in 1998. The number of affiliates of the top
five chaebols had decreased from 262 in April 1997 to 177 by December 1999. (The
number of affiliates of the top 30 chaebols decreased from 819 to 589 during the same
period.)
For the 6th to 64th largest chaebols, restructuring was to be carried out through
workout programs. Financial institutions signed the Corporate Restructuring Agreement,
which provided informal debt-workouts as an alternative to the formal procedures of the
insolvency law regime. These workout programs involved term extensions, deferred
payments and/or the reduction of principal and interest. As of February 2000, 77
corporations of the 6th through 64th chaebols were under workout programs.
7
Under the current workout programs, creditor banks are required to oversee the
management of workout firms as well as the rescheduling of their debts. The creditor
banks, however, lack management expertise and their role is limited to external
supervision, leaving management responsibilities in the hands of company officials. To
promote more efficient management of insolvent firms under workout programs, the
Korean government is currently considering the establishment of Corporate
Restructuring Vehicles (CRVs). A CRV is an independent agency specialized in
corporate restructuring. In place of creditor banks, it will assume the authority to
manage workout firms.
Despite the corporate reform efforts, however, there has been little evidence of
success. For example, the chaebols are actually strengthening their grip over the
economy. According to the Fair Trade Commission, the total amount of the top five
chaebols’ assets increased by 13.8 per cent in 1998. Furthermore, the total debts of the
top five chaebols increased to W 234 trillion in 1998, up from W 221 trillion in 1997.
Nonetheless the debt-equity ratios of the top five chaebols decreased due to the fact that
the chaebols’ mode of financing has changed drastically in favour of direct financing
through the stock market. Some chaebols attracted liquidity through trusts and mutual
funds.
The effectiveness of the Big Deal remains unclear. The new firms made by the
Big Deal remain in financial distress due to unimproved finances because there has been
no debt reduction or injection of new capital. Without lay-offs and plant closures, excess
capacity problems also remain and reducing the number of firms is likely to reduce
competition and facilitate collusive behaviour. As for the workout programs, some
critics argue that preferential financial treatment for the indebted firms might
unnecessarily prolong the lives of failing firms, eat away at banks’ assets and exacerbate
the credit crunch of other firms.
The Korean government has repeatedly announced that the structural reforms
have been and will be driven by market forces. However, it is fair to say that the
structural reform efforts have been driven by government initiative. The government
deeply intervened in the pace and methods of the restructuring process. For example,
the government supported the Big Deal for the chaebol subsidiaries, informally selected
the bankrupt firms for workout programs, set a uniform reduction of the debt-equity
ratio regardless of the characteristics of the business, and implicitly placed a limit on
8
chaebols’ entry into new business. (Samsung Economic Research Institute, 2000)
Thus, the Korean government needs to reduce its level of corporate intervention
and institutionalise a basic corporate governance system and the direction of corporate
sector reforms should be more concentrated on profit maximization, or cost
minimization, rather than just fitting the standard itself.
2.3. Labour Market Reform
The rigidity of the labour market was also pointed out as a key factor that had
contribute to the weakening of the international competitiveness of Korean firms and
thereby helped cause the financial crisis. According to Fitch ICBA (1999), with the
advent of democratisation in 1987 and the subsequent liberalisation of trade unions,
nominal wages increased 15 per cent per annum up until 1996, exceeding productivity
that rose by 11 per cent. However, tight labour market conditions and strong trade union
power ensured that labour market reform went untouched. The labour market was
plagued with rigidity. An excessive degree of job protection prevented lay-offs and
encouraged overmanning, inflexible working hours and few limits on strike action.
Therfore, a major goal of the reform was to ensure flexibility in the labour market.
The Tripartite Commission, composed of representatives from labour,
management and government, was established in January 1998, and the Tripartite Social
Accord was signed in February 1998. The Accord covers not only labour-related, but
also a wide range of socio-economic matters. It includes issues such as the promotion of
freedom of association, management transparency, business restructuring, labour market
policy, reform of the social security system, wage stabilisation, the improvement of
labour-management co-operation, and the enhancement of labour market flexibility.
In February 1998, greater labour market flexibility was instituted with the
revision of the Labour Standard Act (LSA), which legalised lay-offs for ‘managerial
reasons.’ Specifically, lay-offs became possible if four preconditions could be met. First,
there must be an urgent managerial need; second, all efforts to avoid layoffs should
have been exhausted; third, workers to be laid off should be selected by a reasonable
and fair standard; and fourth, agreement should be reached with labour union
representatives. In spite of its very demanding preconditions, the new LSA facilitated
9
necessary lay-offs in the process of financial and corporate sector reforms. In addition
to the new LSA, legislation allowing the establishment of manpower dispatching
businesses took effect in July 1998. Manpower dispatching businesses provide
employment-outsourcing services for 26 work types and 118 job classifications,
including computer professionals, interpreters, secretaries and tour guides. This measure
is also expected to further enhance labour market flexibility.
On the other hand, the basic rights of workers have been strengthened. Teachers
have been allowed to organise labour unions. The coverage of both unemployment
insurance and industrial accident compensation insurance has been widened. Indeed,
many policies and programs were designed to assist the unemployed. However, they
have been able to provide support for only a fraction of those who have lost their jobs in
due to the financial crisis. (Lee and Lee, 2000)
2.4. Public Sector Reform
Poor productivity and rampant inefficiency in the public sector have been
notorious. In the wake of the financial crisis, the Korean government declared it would
launch its own reforms aiming at remodelling the government’s role, and improving the
efficiency and transparency of public administration.
The downsizing of the government has been an important feature of the public
sector reform. The Korean government has pursued streamlining of its organisational
structure. In February 1998, the first reshuffling of the central government structure was
implemented, and 11 chambers, 42 bureaus and 53 departments were scrapped. As a
result, the number of government employees is to be reduced 11 per cent by the end of
the year 2000. In addition, another downsizing plan has been set up to reduce as many
as 16 per cent of the total employees by the year 2001. Local governments have also
streamlined their organisations; by October 1998, 12 per cent of the total jobs had been
eliminated. Additionally, the quasi-government sector, including public institutions and
various associations, has also been streamlined.
State-owned enterprises (SOEs) have also been subject to drastic overhaul by
means of privatisation or management reform. In August 1998, a plan of SOE
privatisation was announced. Among the 108 SOEs, 38 would be immediately
10
privatised, 34 gradually privatised, 9 would be merged into others or liquidated, and 21
would go through restructuring. The 20 institutions of the 109 SOEs were privatised in
1998. The 89 subsidiaries of the 30 parent SOEs are also subject to privatisation or
management reform. Out of 24 non-financial SOEs (parent companies), 5 SOEs are to
be privatised by 1999, 6 SOEs will be gradually privatised by 2002, while the remaining
SOEs are targeted for managerial reform and consolidation.
Elimination of excessive regulation has been another important task in the public
sector reform. The Regulation Reform Committee (RRC) announced that in 1998 it
abolished approximately 49 per cent of the total 11,125 government regulations
pertaining to the private sector.
If is fair to say, however, that many of the public sector reform tasks, and their
actual implementation, have been hardly satisfactory. Many critics argue that the
government, in particular, which has led the structural reform in other sectors, has not
followed through with its own public sector restructuring.
3. Economic Performance
3.1. Evolution of the Crisis in 19983
As briefly mentioned in the Introduction, the immediate IMF program required
that the Korean government implement tight monetary and fiscal policies, as an
emergency stabilisation measure. In particular, the Korean government was asked to
raise interest rates sharply. This measure was expected to stem the outflow of foreign
funds and the rapid depreciation of the exchange rate. The call rate was raised from 12.3
per cent on the 1st December 1997 to 20.7 per cent on the 3rd of December, and further
to 30.1 per cent on the 23rd of December. As a consequence, yields on three-year
corporate bonds soared from around 14 per cent, before the crisis, to more than 30 per
cent, and yields on 91-day commercial paper rose sharply from 13-14 per cent to peak
at 40.8 per cent on December 31st. (See <Figure 1>.) Broad money growth (M3) was
reduced to 13.9 per cent by the end of December 1997 from 16.3 per cent at the end of
November 1997. The IMF also asked Korea to target its fiscal surplus of 0.2 per cent of
3
This section is heavily drawn upon Lee (1999).
11
GDP in 1998 by making contractionary adjustments.
As discussed in the financial sector reform, many troubled financial institutions
were suspended or closed and commercial banks were required to meet the BIS 8 per
cent minimum requirement by September 1998. However, the rollover ratio of shortterm debt declined sharply and usable official reserves were almost depleted in midDecember. For example, the rollover ratio of the seven largest commercial banks fell to
32.2 per cent in December from 58.8 per cent in November and 86.5 per cent in October.
After a brief increase to 435 on the 6th of December, from 379 on the 3rd of December,
the Korea Stock Price Index (KOSPI) kept sliding to reach 351 on the 24th of
December. (See <Figure 2>.) As the speed of depreciation accelerated, the exchange
rate rose from about 1,150 W/US$ at the beginning of the month to almost 2,000
W/US$ at the end of the year.4 (See <Figure 3>.) All of these were in fact much worse
than the IMF had predicted.
When Korea faced imminent default by the 24th of December, the IMF decided
to press the foreign commercial banks to roll over their short-term credits on an
enforced basis. The IMF insisted on the comprehensive debt rollover as a condition for
further disbursements of the IMF lending package. Initially the banks and the Korean
government announced a freeze on debt servicing. On the 16th of January the Korean
government and the banks formally agreed to a complete rollover of all short-term debts
falling due in the first quarter of 1998. On the 28th of January an agreement was reached
to convert US$ 24 billion in short-term debt into claims of maturities between one and
three years (Radelet and Sachs, 1998, p.30). The new arrangements put a brake on the
fall of the won and on the decline in Korea’s stock market.
As the market interest rates soared to the 30 to 40 per cent level, the financial
difficulties of corporations deepened. As the IMF program required financial institutions
to meet the BIS capital adequacy ratios, they became reluctant to provide corporations
4
Before the crisis Korea maintained the so-called market average foreign exchange rate system which
was adopted in 1990. Even though the daily fluctuation band had been widened gradually with the
progress of financial liberalisation, it remained at only 2.25 per cent just before the crisis. On the eve of
its turning to the IMF, the Korean government widened the daily band for exchange rate fluctuation to
10 per cent of the market average rate. On 16 December it shifted to a free-floating exchange rate
system.
12
with funds for fear of incurring new NPLs. Even strong banks came under intense
pressure as foreign creditors refused to roll over loans and domestic depositors fled to
foreign-owned banks. The merchant banks, in particular, which used to provide
corporations with short-term funds, virtually suspended new lendings to corporations
and tended to refuse rolling over loans falling due.
This, in turn, made the situation even worse for the debt-ridden corporations,
resulting in a boost in the number of insolvencies to three times the pre-crisis level.
Bankruptcies in Korea hit 3,197 in December 1997, rising to 3,323 in January 1998,
before falling back to 2,749 in March 1998. The ratio of dishonoured bills rose
drastically to 2.1 per cent in December 1997 from 0.5 per cent in November 1997.
As a consequence, the external liquidity crisis became a full-fledged economic
crisis as the full extent of the collateral damage to the real sector became apparent.
During the first quarter of 1998, real gross domestic product (GDP) recorded a negative
growth rate of -4.6 per cent on a year-on-year basis, for the first time in eighteen years,
followed by -8.0 per cent, -8.1 per cent and -5.9 per cent in the second, third and fourth
quarters. In 1998, real GDP dropped 6.7 per cent. The unemployment rate increased
sharply to 6.8 per cent in 1998, in shark contrast to the 2.6 per cent of 1997. (See
<Figure 4>.) Per capita GNP is estimated to have remained at about US$ 6,300 in 1998,
down sharply from US$ 9,511 in 1997 and US$ 10,542 in 1996, and fell short of the
US$ 6,745 recorded in 1991.5
Meanwhile the current account, which recorded a deficit every month until
October 1997, has recorded surpluses since November 1997. In 1998 the current
account recorded a surplus of US$ 40 billion, which was the largest in history. (See
<Figure 5>.) However, this was brought about mainly by a decline in imports rather
than an increase in exports. Despite the potential for increased profitability from the
exchange rate depreciation, exporters were also badly affected because those with
confirmed orders were unable to obtain trade credits and export demand for Korean
products shrunk, as the Asian crisis spread. In 1998 Korean exports declined 2.8 per
cent on a year-on-year basis to US$ 132.3 billion, while imports plunged 35.5 per cent
to US$ 93.3 billion.
5
The sharp fall in per capita GNP was attributed not only to the economic contraction, but also largely to
the Korean won’s sharp depreciation.
13
3.2. Signs of Recovery in 1999
Signs of recovery started to appear in early 1999. In the first and second
quarters of 1999, real GDP rose 5.4 per cent and 10.8 per cent, respectively, on a yearon-year basis. Overall, real GDP rose 10.7 per cent in 1999. After peaking at a 17-year
high of 8.6 per cent in February 1999, the unemployment rate declined steadily. The
annual average jobless rate in 1999 was 6.3 per cent. The current account balance
reached US$25 billion in 1999. Thanks to large current account surpluses, Korea’s
usable foreign exchange reserves grew continuously, reaching US$ 74.1 billion in
December 1999, in sharp contrast with the US$ 8.8 billion at the end of 1997. The total
external liabilities of Korea were US$ 136.4 billion as of the end of December 1999,
which is US$ 22.8 billion smaller than that at the end of 1997. (See <Table 1>.)
Reflecting the economic recovery, foreign capital inflows have rapidly increased. Korea
attracted about US$15.5 billion of FDI in 1999, nearly twice the US$8.9 billion
achieved in 1998. Not surprisingly, the role of FDI in the Korean economy has
increased; it accounted for approximately 8% of the GDP in 1999, in contrast to less
than 3% in 1996. The W/US$ exchange rate has appreciated to below 1200 and remains
stable, mainly due to the current account surplus and inflows of foreign investment.
(See <Figure 3>.) In February 1999, Standard & Poors, an international credit rating
agency, raised Korea’s sovereign credit rating to BBB-, almost the same level before the
outbreak of the crisis.
Higher-than-expected economic growth resulted from the rebound of the world
economy as well as the restoration of financial confidence in Korea, reflected in lower
interest rates, the stock market boom, and increasing industrial production. Low interest
rates since mid-1998 have produced favorable economic conditions for financial market
and corporate restructuring in Korea. In 1999, the domestic interest rates remained
stable at a lower level of between 7 to 8 per cent. (See <Figure 1>.) Due to the lower
interest rates, the investors turned to the stock market. In 1999, the benchmark Korea
Stock Price Index (KOSPI) recorded a 75 per cent rise from 588 points at the beginning
of the year to 1,028 points by year-end. (See <Figure 2>.) Due to the booming stock
market, listed companies raised more than 46 trillion won on the Korea Stock Exchange
(KSE) and 3.5 trillion won on the KOSDAQ market.
14
Even though the general economic conditions of Korea have improved, some
adverse consequences have emerged during the process of crisis resolution. Specifically,
the government and public debt have grown due to the expenditures on financial
restructuring and expanded social programs. The ratio of national debt to GDP increased
from 11.7 per cent in 1997 to almost 20 per cent in 1999.
4. Challenges Ahead
In April 2000, Korea’s usable foreign exchange reserves reached US$ 84.6
billion. (See <Table 1>.) The Korean economy also showed a high growth rate, of
12.8%, (See <Figure 4>) and the unemployment rate decreased steadily and reached 5.1
per cent in the first quarter of 2000. (See <Table 1>.) The exchange rate has
strengthened and interest rates have remained at levels below where they stood before
the crisis erupted. (See <Figure 3>.) It now seems that the Korean economy has
overcome the worst of the crisis and the possibility of a repetition of 1997’s external
liquidity crisis has been significantly reduced. However, unstable elements and
conditions are increasingly appearing both inside and outside the nation. Among the
destabilising factors inside Korea are the ailing investment trust companies and the
reduction of the current account surpluses. Globally, the slowdown of the U.S. economy,
high oil prices, and the financial instability in Southeast Asia are casting a shadow on
the Korean economy.
4.1. Internal Challenges
On the surface, the financial market and corporate sector reforms have been
successful. For instance, the banks and the chaebols have more than met the
government’s conditions, imposed following the financial crisis. As of the end of 1999,
the average BIS ratio of the 17 domestic commercial banks was well above the BIS
recommended level of 8 per cent, and the chaebols lowered their borrowing to below
200 per cent of their equity.
However, in June 2000, Korea’s financial market was once again severely
rattled and, as The Economist (3 June 2000) puts it, the country seemed to be back on
the brink of financial crisis. Specifically, on the 26th of May 2000, lenders to the two
subsidiaries of the largest chaebol, Hyundai, refused to renew short-term loans. As a
15
consequence, the stock market plunged. Hyundai’s troubles began with fears over the
health of the group’s investment-trust company, Hyundai Investment Trust & Securities,
which was thought to have a 1.2 trillion won hole in its finances and had debts worth
approximately 3 trillion won that will fall due by the end of 2000. Hyundai Investment
Trust is 51%-owned by two other Hyundai companies, which are also owned by other
Hyundai companies, and so forth. Thus, this cross-ownership means that the collapse of
Hyundai Investment Trust can put the entire group at risk. Therefore, creditors lost faith
in the Hyundai group’s resolve to cut its debts, and finally refused to renew short-term
loans falling due. At the urging of the government, Hyundai announced a hasty
restructuring plan, which includes the retirement of Hyundai’s founding family
members. This restored some calm to the markets.
However, Korea’s financial distress does not seem to be over yet, because
Hyundai Investment Trust is not alone. Korea Investment and Daehan Investment are
also in danger. All this renewed financial distress proves that the financial and corporate
reforms have been superficial, and the financial markets are still very fragile. The
capital adequacy ratio of the commercial banks was significantly improved by the
injection of public funds and the infusion of subordinated debt. However, the bad loans
still remain high and may increase due to potential further distress of the corporate
sector. The recent Daewoo and Hyundai cases showed the possibility of such distress.
Investment-trust companies were at the root of the recent distress of Korea’s financial
stability. However, banks seem to be running into some trouble as well, as they are also
large shareholders in the trust companies. In fact, most domestic banks in Korea are still
classified as non-investment grade by major international credit rating agencies.
Thanks to large current-account surpluses in 1998 and 1999, the banks and the
chaebols have repaid or refinanced some of their short-term foreign debts, and the
government has amassed huge foreign-exchange reserves. As imports grow more
rapidly than exports, however, the current-account surpluses are shrinking rapidly. (See
<Figure 5>.) Korea may soon experience a current-account deficit and become a net
importer of capital again. In fact, Korea’s external liabilities were US$140.4 billion in
April 2000, up from US$136.4 billion in December 1999. The nation’s short-term
external liabilities also rose from US$ 38.1 billion in December 1999 to US$ 46.2
billion in April 2000, recording a weight of 32.9 per cent of the nation’s total foreign
debt and 54.6 per cent in its official foreign exchange reserves, which reached US$84.6
billion in April. (See <Table 1>.) This suggests that the financial and corporate sector
16
reforms should be pursued in a timely manner.
The social consequences of the financial crisis and subsequent structural
reforms also warrant a close look. There have been tumultuous and painful side-effects
for most Koreans in all segments of Korean society. In particular, the crisis and Korea’s
structural reform process have had significant and adverse effects on equitable growth
in Korea. Specifically, low-income households and marginal workers, such as women,
young workers, the less educated, wage workers, and first-time jobseekers, were the
hardest hit and the existing social protection systems have been unable to adequately
cope with the social consequences of the crisis, and as a consequence, income
distribution in Korea has deteriorated. (Lee and Lee, 1999) Therefore, special efforts to
strengthen social protection systems are greatly needed.
4.2. External Challenges
First of all, there is a risk that the U.S. stock market might collapse if the
foreign capital inflow slows down due to the vast current account deficit and external
liabilities of the U.S.A. As the L.A. Times reports, “a sharp U.S. slowdown could spread
pain at home and damaging fallout in a closely connected world economy.” (L.A. Times,
12 June 2000) Even though this scenario is a remote possibility, the U.S. economy will
slow down because of its successive interest rate hikes. Korea’s exports to the U.S.A.
will then see a downturn as U.S. private expenditure declines.
The European Union (EU) has also raised its interest rates in an effort to
prevent the devaluation of the Euro. This worldwide trend of high interest rates can
become a serious threat to Korea and to other East Asian countries whose financial
markets are still fragile. This is because unless the East Asian countries also increase
their interest rates, foreign capital may pull out of these countries. And if they increase
interest rates to avoid such a situation, the interest burden of firms will increase and an
extra financial stress will follow.
On the other hand, the Southeast Asian financial markets have become
increasingly unstable since the end of 1999. This is due to the uncertainties of the world
economy and the diminished confidence of foreign investor in these markets in the face
of the political unrest and delays in their restructuring processes. If the Southeast Asian
17
countries face a threat similar to the 1997 financial crisis and competitive currency
devaluation, there can be no doubt that Korea will again very likely be adversely
affected.
The current upward trend of international oil prices is also worrisome. The
price of West Texas Intermediate oil, for example, surpassed US$ 30 on the 18th of May
2000, to the highest level in the past nine years. As a result, Korea’s energy imports
during the first quarter of 2000 surged 120 % on a year-on-year basis to a total of
US$ 9.1 billion. If the oil prices remain high, this will put intensive pressure on the
Korean economy by pushing domestic prices upward while simultaneously pulling
current account surpluses downward.
5. Concluding Remarks
Based on the post-crisis economic developments in Korea, it is fair to say that
the likelihood of a repetition of the turmoil in the Korean economy has declined
considerably. However, there remain many internal and external obstacles to the full
recovery of the Korean economy. If any of the obstacles are not adequately overcome,
the crisis could turn out to be an even more enduring pain for the Korean people. On the
other hand, if positive preconditions are met and the structural reforms are
accomplished smoothly, the crisis could turn out to be a blessing in disguise that will
pave the way for another economic miracle and sustainable growth for Korea in the
twenty-first century. (Lee, 1999)
Therefore, there is a strong need for continued efforts to safeguard
macroeconomic stability, implement structural reforms, and attain sustained growth
through increases in efficiency and productivity. In line with this, Korea has to establish
a true market economy – an economy led by the private sector and the basic principles
of transparency, accountability and fair competition but guided by prudential
supervision.
18
<Table 1> External Liabilities and Credit
End of 97 End of 98
Total External Liabilities
159.2
Long-term Liabilities
95.7
Short-term Liabilities
63.6
Short-term Debt/Total Debt (%) 39.9
Total External Credit
105.2
Net External Liabilities
-54.1
Foreign Exchange Reserves
8.8
148.7
118.0
30.7
20.6
128.5
-20.2
48.5
Short-term Debt/FX Reserves (%) 722.7
63.3
(Unit: US$ billion)
End of 99 End of April 2000
136.4
98.3
38.1
27.9
145.7
93.0
74.1
140.4
94.2
46.2
32.9
156.0
15.6
84.6
51.5
54.6
Source: Ministry of Finance and Economy, the Bank of Korea
<Figure 1> Yields on Three-year Corporate Bonds (%)
<Figure 2> Korea Stock Price Index (KOSPI; 1980=100)
<Figure 3> Exchange Rate (W/US$)
<Figure 4> Real GDP Growth Rate, Inflation Rate and Unemployment Rate (%)
<Figure 5> Current Account Balances (Billion US$)
19
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